Defense Spending Growth Lures Odebrecht, EADS: Corporate

By Raymond Colitt -
Aug 16, 2012

The unmanned aircraft soaring above
Brazil’s Paraiba valley looks like a toy plane. In fact, it is
the newest means of monitoring drug and arms traffickers, and
the latest result of a military buildup that is attracting
companies from Boeing Co. (BA) to Odebrecht to Thales SA.

The suppliers, facing possible reductions in defense
spending in the U.S., U.K. and countries worldwide, are
jockeying to take a bigger share of Brazil’s defense contracts.
The industry has expanded 236 percent in the past four years to
12 billion reais ($5.9 billion) in annual spending, according to
the Defense Ministry.

Brazil is replacing aging military equipment to develop its
own technology and create jobs, industry executives say. The
nation of more than 210 million people has avoided armed
conflicts with its 10 neighbors for 142 years and hasn’t been
involved in a war since 1945.

“It’s a very promising market, everybody knows Brazil’s
importance is growing in the global arena,” said Ramiro Brasil,
administrative manager at Sao Jose dos Campos, Brazil-based
Flight Technologies, which delivered three prototype drone
aircraft to the army last year and is testing its smaller, hand-
launched model. “Finally there are public policies that sustain
the defense industry.”

Brazilian President Dilma Rousseff in March signed
legislation that grants a series of tax breaks over five years
for companies providing strategic defense goods and services.
The move is part of a broader strategy, announced in 2008, to
shift Brazil’s capabilities away from conventional warfare to
surveillance and protection of infrastructure and natural
resources, particularly in the Amazon and offshore regions.

Defense Companies

The number of foreign and domestic defense companies in
Brazil jumped to 150 last year from 39 in 2007, with sales of
$3.5 billion, according to the Brazilian Defense and Security
Industries Association, or ABIMDE. The government has signed
contracts for equipment worth more than $12 billion and the
Defense Ministry estimates the armed forces will need annual
investments of 20 billion reais over the next two decades.

Brazil’s main construction companies, including Odebrecht
and Queiroz Galvao SA, are joining in the competition for
contracts. Belo Horizonte, Brazil-based Andrade Gutierrez SA
created a defense joint venture in January with aerospace and
industrial electronics company Thales SA (HO) of France.

Embraer SA (EMBR3), the world’s fourth-largest airplane maker,
projects defense revenue to grow 17 percent this year to 1
billion reais and to account for a quarter of its income by
2020, up from 14.7 percent now, according to an e-mail from the
Sao Jose dos Campos-based company. Its shares rose 2.41 percent
at 1:37 p.m. local time, compared with a 1.1 percent rise for
the Bovespa index.

‘Potential Positive’

“We view the company’s increasing revenues in the defense
segment as a potential positive in the next few years,”
Standard and Poor’s said in a June report.

Shares in Forjas Taurus SA (FJTA4), the Porto Alegre, Brazil-based
company that makes firearms, rose 7.28 percent today. It is up
100 percent for the year, compared with the Bovespa’s gain of
3.7 percent.

Underlying the need to beef up a military with 328,000
troops, the second-largest force in the Americas, is a
conviction among policy makers that the country’s defensive
capacity should be in line with its growing economic clout.

“In the past we had limited budgets because of our large
foreign and social debts,” army General Aderico Mattioli, head
of product development at the Defense Ministry, said in an
interview. “With the new economic reality we can think of the
country’s defense again.”

Share of GDP

While Brazil last year overtook the U.K. to become the
world’s sixth-largest economy, its defense spending as a share
of gross domestic product ranked it 88th among 172 countries,
according to the latest U.S. Central Intelligence Agency World
Factbook. Last year Brazil spent 61.8 billion reais, or 1.5
percent of GDP, according to the Defense Ministry. The U.S.
spent 5.1 percent of GDP on defense last year, according to data
compiled by Bloomberg.

Some entrepreneurs are wary that slower economic growth may
lead policymakers to cut the defense budget. Economists surveyed
by the central bank forecast 1.8 percent growth this year, down
from 7.5 percent in 2010 and 2.7 percent last year.

“There’s some uncertainty whether spending will continue
at its current rate,” said Luiz Carlos Teixeira, chief
executive officer of Sao Jose dos Campos-based IACIT, which is
developing maritime and meteorological radars able to detect
tsunamis and low flying aircraft. Shifts in spending are
particularly disruptive to small- and medium-sized companies
that often depend on a few defense contracts, Teixeira said.

Border Defense

The government is pushing ahead with planned projects and
last week took offers for its border defense system, which may
include the type of unmanned aircraft tested by Flight
Technologies over the Paraiba Valley.

Brazil’s discovery of 5 billion to 8 billion barrels of
offshore oil reserves in 2007 has triggered a new awareness of
security needs in a country that has 4,625 miles of coastline
and limited naval capabilities, including one aircraft carrier,
built in 1960.

“Nobody wants to go to war, but when you discover huge oil
reserves 200 miles off your coast, somebody has to protect
them,” ABIMDE’s executive vice-president, retired Admiral
Carlos Pierantoni, said in a June telephone interview.
Pierantoni expressed concern over a possible scenario in which
pirates took control of an offshore oil platform and announced,
“ ‘Either you give me $200 million or I’ll blow it up.’ ”

Helibras, EADS

The defense push has led foreign companies to set up shop
or expand production capacity in Brazil. Helibras, controlled by
Toulouse, France-based European Aeronautic, Defence & Space Co.,
this year will begin production of 46 of 50 EC725 helicopters
worth 1.8 billion euros ($2.2 billion) for Brazil’s armed forces
at a new plant in Minas Gerais state, the company said in an e-
mail. The first four were made in Europe. A civilian version of
the helicopter is designed to ferry supplies and personnel to
offshore oil rigs.

Boeing’s F/A-18E/F Super Hornet, French Dassault Aviation
SA (AM)’s Rafale and Swedish Saab AB (SAABB)’s Gripen are competing for a
deal to deliver 36 jet fighters that the U.S. State Department
says is worth as much as $4 billion. The decision has been
repeatedly delayed, and Rousseff’s office in an e-mail said it
has no estimate of when it may occur.

In a departure from previous defense contracts, foreign
investors, including the winning jet fighter contractor, will be
expected to partner with local companies, transfer technology
and maximize local production. “We have no aversion to foreign
capital, what we want is a commitment to develop national
production capacity,” said Mattioli.

Sharing Know-How

Boeing agreed in June to share know-how and market studies
with Embraer for the KC-390, a military cargo aircraft to be
built in Brazil. The companies will offer the plane as a global
competitor to Bethesda, Maryland-based Lockheed Martin Corp. (LMT)’s
Hercules C-130.

Chicago-based Boeing in March chose AEL Sistemas, a
subsidiary of Israel’s Elbit Systems Ltd. (ESLT) located in Brazil’s
Rio Grande do Sul state, to develop and produce advanced cockpit
avionics, and is looking for local partners in other defense
sectors. Brazil is “an opportunity” as a defense market,
production and research center, Donna Hrinak, president of
Boeing Brazil, said by phone from Rio de Janeiro.

Italy’s Iveco SpA this year will build the first of 2,044
armored personnel carriers worth a total of 2 billion euros at a
plant in Sete Lagoas in Minas Gerais state.

France’s DCNS SA and Brazil’s Construtora Norberto
Odebrecht SA are building five submarines, one of them nuclear-
powered, in Rio de Janeiro state, costing the government 9.6
billion reais between 2012 and 2015, the Defense Ministry said.

Niche Markets

Based in the Sao Jose dos Campos industrial hub near Sao
Paulo, Avibras Industria Aeroespacial SA has created niche
markets for itself abroad. Foreign sales make up 80 percent of
Avibras’s $210 million in annual revenue, and the Middle East is
the biggest client for its flagship export item of missiles and
rockets. U.S.-led troops used Avibras’s Astros II multiple
rocket launcher to attack Iraqi forces in Operation Desert Storm
during the Gulf War.

Brazil is following the same model other defense exporters
have. “The government helps a little to develop products and
then you start exporting, generate profits, jobs and foreign
exchange,” said Sami Youssef Hassuani, president of Avibras.

Products containing sensitive U.S. components could face
export limitations under U.S. law. In 2006 the U.S. government
blocked Embraer’s sale of Super Tucano turboprops to Venezuela.

$1 Billion

Embraer and its partner Sierra Nevada Corp. are competing
against Hawker Beechcraft Corp. for a U.S. Air Force contract
worth as much as $1 billion to deliver light-attack aircraft to
the Afghan military after the first contract it won was canceled
in February because Hawker filed a suit over the decision. On
July 10, Embraer signed a contract for a second batch of 8 Super
Tucano planes to Indonesia’s air force.

While a growing defense industry in Latin America would
have been unwelcome in Washington only a few decades ago, Brazil
now is seen as a regional and global source of stability, U.S.
Defense Secretary Leon Panetta said in April.

“There was a time when the United States discouraged
developing military capability in countries in Latin and Central
America,” Panetta told reporters after meeting Defense Minister
Celso Amorim in Brasilia. “The fact is today, we think the
development of those kinds of capabilities is important and if
we can use those capabilities to develop the kind of innovative
partnerships that I’m talking about, that will advance the
security in this region.”